The religion of the invisible hand

The author of this blog is a friend of mine and a philosopher, specializing in logic and religion. He does occasionally have interesting thoughts on economics as well as this post shows.

I agree that to some schools within economics the invisible hand is religion. They have been blessed (or cursed) with eternal faith in it. I’m not among those, but then again, I think that applies to many environmental economists.

As a final note on Thatcher and individualism: there has been a long debate (and still is) in economics on how to add up the preferences of individuals to figure out the preferences of society as a whole. And then Kenneth Arrow proved under very reasonable assumptions about humans that it was not possible!
(http://plato.stanford.edu/entries/arrows-theorem/)

Does that mean that society does not exist, or should not on occasions make choices for individuals? Of course not! But it does mean that we should be very careful when making decisions, and look at who is influenced. And that is in fact what environmental economics is all about…

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Published by Maarten Punt

I am a resource economist with my main interests in the economics of conservation, although I make occasional excursions in agricultural or development economics.
I use spatial optimization and game theory to gain insights in what drives people and countries in their decisions. By understanding their behaviour I hope to be able to make the world just a tiny bit better.... one step at a time
View all posts by Maarten Punt

2 thoughts on “The religion of the invisible hand”

Thanks for the link Maarten! As you already pointed out, Arrow’s theorem is not a justification for general pessimism. The fact that there is no algorithm to establish a social optimum in every case does not mean that there are no cases of social optima whatsoever. In a cohesive group there are preferences that are generally held to have a certain place in a hierarchy of values. Of course, not every group is cohesive and this is why we see torn states, destroyed families and failed defense lines in basketball. The question for Schumpeter and Popper was: in a cohesive group, is the social preference totally reducible to individual preferences? Or are there any collective goods that are not reducible to individual preferences? Popper and Schumpeter would say that there are no such things as collective goods. In fact the historical examples of such goods are exotic to say the least. Things like: “Actually I’d prefer a European-style motorway but considering the fact that our country is not a European country (and proud of its identity), I prefer our motorways the way they are”. Now, this sounds like puting a collective good that no car driver has as an individual, in front of the individual preference, and the collective good is not reducible to the individual preference but, to my mind, if there are people who think that way, then they’re not sane in the sense that they affirm cognitive dissonance, or their nationalism (an individual preference!) has to enter the calculation.

Thanks for your post, Maarten. Just a few short remarks: Adam Smith’ own concept of the Invisible Hand was somewhat different from the one commonly attributed to him, i.e., the assumption that, left to itself, a perfectly competitive market will lead to pareto efficiency under restrictive assumptions. While few economists would probably argue that actual markets conform to the standard version of the Invisible Hand, many (including myself) probably see the Invisible Hand Theorem as important in explaining why free markets, with their lack of central coordination, do not simply lead to chaos – despite the problems associated with market exchange. There is an element of religion, however, in the axiomatic approach of mainstream economic theory. To the extent that empirically refutable assumptions (dogma) are believed and form the basis for political decision-making, the theoretical edifice may be seen as a religion. The problem is that, due to the small capacity of our brains, we have to make sense of a complex world by means of simple models. The Invisible Hand theorem is actually a good demonstration of the heuristic value of such models. Still, while we may be able to match the internal consistency of Newtonian physics, we are nowhere near the level of correspondence between theory and fact achieved by classical mechanics. A century ago economists like von Wieser advocated the method of decreasing abstractions, seeing the heroic abstractions of textbook models as the initial steps of a long journey towards a more realistic and complex theory. Unfortunately, this strategy soon reached its limits. Highly complex theories are simply unmanageable – and certainly don’t lend themselves well to journal articles. Instead, we are, in practice, in the pragmatic business of looking at the same complex realities from the perspectives of alternative simple models. Does this mean that all is well? Not necessarily. The normative implications of basic assumptions such as individual utility maximization, for example, or rational expectations, are often highly sensitive to the precise specification of these assumptions.